Financial Statements: Analysis, Reporting and Valuation

Acknowledgments
Disclaimer
Contents
Abbreviations
List of Tables
Part I Overview of Financial Statements and the Statement of Position
1 Overview of Financial Statements
1.1 General
1.2 The International Accounting Standard Board: IFRS
1.3 European Financial Reporting Advisory Group (EFRAG)
1.4 The United States: The FASB
1.5 The United Kingdom: Financial Reporting Council (FRC)
1.6 Japan: The Accounting Standard Board of Japan
1.7 Australia: The Australian Accounting Standard Board
1.8 New Zealand: The New Zealand Accounting Standards Board (NZASB)
1.9 India: The Council of the Institute of Chartered Accountants of India (ICAI)
1.10 China: Accounting Standard for Business Enterprises
1.11 The Financial Statement Materials
1.11.1 The Proxy Statement
1.11.2 The Management Discussion & Analysis (MD&A)
1.12 Interim Statements and Subsequent & Adjusting Events
1.12.1 Interim Financial Statements
1.12.2 Subsequent Events
1.12.3 Adjusting Events
1.13 Users of Financial Statements
References
2 Short-Term Assets: Cash and Cash Equivalents
2.1 General
2.2 Cash and Cash Equivalents
2.2.1 Bank Reconciliation
2.2.2 Bank Overdraft
2.2.3 Petty Cash
2.3 Marketable Equity Securities and Fair Value Measurement
2.4 Accounting for Financial Instruments
2.5 Accounting for Derivatives
2.6 Accounting for Hedging
References
3 Short-Term Assets Inventories
3.1 General
3.2 Inventory Methods
3.2.1 The Perpetual Inventory System
3.2.2 The Periodic Inventory System
3.3 Ownership Issues
3.4 Valuation of Inventory
3.5 The LIFO Reserve
3.6 LIFO Liquidation
3.7 Comprehensive Example
3.7.1 Solutions:
3.8 Restrictions on the Use of LIFO
References
4 Account Receivables
4.1 General
4.2 Cash Discount on Sales
4.2.1 The Gross Method
4.2.2 The Net Method
4.3 Bad Debts Concept
4.3.1 Rebates
4.3.2 Doubtful Accounts
4.3.3 Accounting for Bad Debts
4.4 Accounts Receivable Aging Method
4.5 Assignment of Accounts Receivable
4.6 Factoring of Accounts Receivable
4.6.1 Recourse vs Non-Recourse Factoring
4.6.2 Factoring V. Loan
4.6.3 Factoring vs Assignment of Receivables
4.7 Securitization of Receivables
4.7.1 Sale Accounting Criteria
4.7.2 Secured Borrowing
4.8 Receivables—Troubled Debt Restructurings by Creditors
4.9 Non-Trade Receivables
References
5 Prepaid Expenses, Unearned Income, and Other Current Assets
5.1 General
5.2 Prepaid Expenses
5.3 Unearned Income
5.4 Other Current Assets
References
6 Short-Term Liabilities & Working Capital
6.1 General
6.2 Accounts Payable
6.3 Notes Payable
6.4 Current Maturities of Long-Term Debt
6.5 Other Current Liabilities
6.6 Commercial Paper
6.7 Working Capital
6.7.1 Determinants of Working Capital
6.7.2 Financing of Working Capital
6.7.3 Computation of Working Capital: Example
7 Long-Term Assets: Plant, Property, and Equipment
7.1 General
7.2 Property, Plant, and Equipment
7.2.1 Acquisition of Property, Plant, and Equipment
7.2.2 Cost of Land
7.2.3 Cost of Buildings
7.2.4 Cost of Equipment
7.3 Valuation of Property, Plant, and Equipment
7.4 Amortization, Depreciation, and Depletion
7.4.1 Straight-Line Method of Depreciation
7.4.2 Declining Balance Method of Depreciation
7.4.3 Double Declining Balance Depreciation Method
7.4.4 Units of Production Method of Depreciation
7.4.5 Sum of the Years’ Digits Method of Depreciation
7.5 Disposition of Property, Plant, and Equipment
7.5.1 Sale of Plant Assets
7.5.2 Involuntary Conversion
7.5.3 Miscellaneous Problems
References
8 Long-Term Assets: Intangibles
8.1 General
8.2 The Goodwill
8.2.1 Goodwill Impairment
8.3 Computer Software
8.3.1 Research and Development Costs of Computer Software
8.3.2 Production Costs of Computer Software
8.3.3 Purchased Computer Software
8.3.4 Amortization of Capitalized Software Costs
8.3.5 Presentation and Disclosure of Software Costs
8.3.6 Software Purchased Before Technological Feasibility Established
8.3.7 Disclosure of Risks and Uncertainties Related to Capitalized Software Costs
References
9 Long-Term Liabilities: Leases
9.1 General
9.2 Lease
9.2.1 Legal Definition of a Lease
9.2.2 Advantages and Disadvantages of Leasing
9.3 Types of Leases
9.3.1 Finance Lease
9.3.2 Operating Lease
9.4 Sale-Leaseback
9.4.1 Sale-Leaseback Advantages
9.4.2 Accounting Analysis
9.5 Short-Term Lease
9.6 Lease Disclosure
9.6.1 In the Balance Sheet
9.6.2 In the Statement of Cash Flows
References
10 Long-Term Liabilities: Pension & Postretirement Liabilities
10.1 General
10.2 Types of Pension Plans
10.2.1 Defined Contribution Plan
10.2.2 Defined Benefit Plan
10.3 Net Pension Asset/Liability
10.4 Projected Benefit Obligations
10.5 Plan Assets
10.6 Reporting Pensions Plans on Financial Statements
10.6.1 In the Statement of Income
10.6.2 In the Balance Sheet
10.7 Funded Status
10.8 Postretirement Benefits Other Than Pensions
References
11 Shareholders’ Equity
11.1 General
11.2 Common Stock
11.2.1 Par Value of Common Stock
11.2.2 Stated Value of a Common Stock
11.2.3 Authorized Capital
11.2.4 Issued Capital
11.2.5 Outstanding Capital
11.3 Issuance of Shares of Stock
11.3.1 Issuance of Par Value Stock
11.3.2 Issuance of no Par Stock
11.4 Issuance of Shares for Non-Cash Items
11.5 Lump Sum Stock Issuance
11.6 Treasury Stock—Cost Method
11.7 Treasury Stock—Par Value Method
11.8 Stock Dividends
11.8.1 Small Stock Dividend
11.8.2 Large Stock Dividend
11.9 Employee Stock Options
11.9.1 Legal Understanding
11.9.2 Statement of Financial Accounting Standard No. 123
11.9.3 Illustration
11.9.4 Stock Splits
11.9.5 Retained Earnings
References
Part II The Statement of Income
12 Analysis of the Statement of Income
12.1 General
12.2 The Single-Step Income Statement
12.3 Multiple-Step Income Statement
12.3.1 Analysis of the Multiple-Step Components
12.3.2 Format and Example
12.4 Holding Equity
12.5 Income from Discontinued Operations
References
13 Other Comprehensive Income
13.1 General
13.2 Presentation of the OCI
13.3 Accumulated OCI
13.3.1 Foreign Currency Accounting
13.3.2 Discontinued Operations
13.4 Reclassification Out of Accumulated Other Comprehensive Income
13.4.1 Presentation on the Face of the statement—in Net Income
13.4.2 Presentation as a Separate Disclosure in the Notes
13.5 Earnings Per Share
13.5.1 The Computation of the Simple EPS
13.5.2 The Computation of the Diluted EPS
13.5.2.1 Dilution through the Issuance of Stock Options
References
14 The Sub-Statement of Retained Earnings
14.1 General
14.2 Steps in Preparing the Statement of Retained Earnings
14.3 Retained Earnings Formula:
14.4 Changes in Retained Earnings
14.4.1 Accounting Changes and Retained Earnings
14.4.2 Accounting Errors and Retained Earnings
References
15 The Computation of the Taxable Income
15.1 General
15.2 Differed Taxes & Assets
15.2.1 Temporary Differences for Revenue and Expenses
15.2.2 Permanent Differences
15.3 Net Operating Losses
15.4 Undistributed Profits of Foreign Subsidiaries
15.5 APB 23 and Indefinitely Reinvested Earnings
15.6 ASC 740: Accounting for Uncertainty in Income Taxes (Formerly FIN 48)
15.7 Financial Statement Reporting
15.7.1 Statement Reporting
15.7.2 Presentation
15.7.3 Disclosure
References
Part III The Statement of Cash Flows & Financial Ratios
16 Analysis of the Statements of Cash Flows
16.1 General
16.2 Classification of Cash Flows
16.2.1 Cash Flows from Operating Activities
16.2.2 Cash Flows from Investing Activities
16.2.3 Cash Flows from Financing Activities
16.3 Content and Form of the Statement of Cash Flows
16.3.1 Reporting Cash Flows from Operating Activities
16.3.2 Quick Analysis of the Operating Cash Flows
16.4 Examples
16.4.1 Example of Operating Cash Flows
16.4.2 Example with Investing Cash Flows
16.4.3 Example with Financing Cash Flow Activities
16.5 Noncash Investing and Financing Activities
References
17 Financial Ratios Analysis
17.1 General
17.2 Liquidity Measurement Ratios
17.3 Solvency Ratios
17.4 Profitability Indicator Ratios
17.5 Efficiency Ratios
17.6 Debt Ratios
17.7 Operating Performance Ratios
17.8 Cash Flow Indicator Ratios
17.9 Investment Valuation Ratios
17.10 Strategic Financial Ratios
17.11 Bankruptcy Ratios
17.11.1 Working Capital/Total Assets
17.11.2 Retained Earnings/Total Assets
17.11.3 Earnings Before Interest and Taxes/Total Assets
17.11.4 Market Value of Equity/Book Value of Total Debt
17.11.5 Sales/Total Assets
17.12 Limitations
References
Part IV Pro-Forma Financial Statements
18 Forecasting Financial Statements’ Analysis
18.1 General
18.2 The Forecasted Statement of Income
18.2.1 Sales Forecasting
18.2.2 Production & COGS Forecasting
18.2.3 Expenses’ Forecasting
18.3 The Forecasted Statement of Position
18.3.1 Making Assumptions
18.4 The Forecasted Statements of Cash Flows
18.4.1 Forecasting Operating Cash Flows
18.4.2 Forecasting Financing Cash Flow
18.4.3 Forecasting Investing Cash Flow
References
Part V Consolidated Financial Statements
19 Foreign Currency Accounting
19.1 General
19.2 Determination of the Functional Currency of the Foreign Entity
19.2.1 Factors to Be Considered
19.2.2 Changing the Functional Currency
19.3 Translation Methods
19.3.1 Current/Noncurrent Method
19.3.2 Monetary/Nonmonetary Method
19.3.3 Temporal Method
19.3.4 Current Rate Method
19.4 Re-Measurement into the Functional Currency
19.4.1 The Foreign Entity Does not Book or Record in Functional Currency
19.4.2 Highly Inflationary Economies—US GAAP
19.5 Hedging Balance Sheet & Forecasted Exposure
References
20 Consolidated Financial Statements
20.1 Overview
20.2 Purpose of Consolidation
20.3 Consolidation Methods
20.4 Consolidation Theories
20.4.1 Parent Company Theory
20.4.2 Contemporary/Entity Theory
20.4.3 Traditional /Hybrid Theory
20.5 The Consolidation Process
20.6 Pushdown Accounting
References
21 Segment and Intermediary Financial Statements
21.1 General
21.2 Segment Statements
21.2.1 Reportable Segments
21.2.2 Identification of Additional Segment
21.2.3 Disclosure Requirements
21.2.4 Measurement
21.2.4.1 Reconciliations
21.2.4.2 Interim Report
21.2.4.3 Restatement of Previously Reported Information
21.2.5 Entity-Wide Information
21.2.5.1 Information About Products and Services
21.2.5.2 Information About Geographic Areas
21.2.5.3 Information About Major Customers
21.2.6 Goodwill Considerations
21.3 Intermediary Statements
References
22 IFRS and GAAP
22.1 General
22.2 Principles Based vs. Rules Based
22.3 Selected International Accounting Standards
22.3.1 IAS 1—Presentation of Financial Statement
22.3.1.1 Complete Set of Financial Statements
22.3.1.2 Core Principles
22.3.1.3 Financial Statements: Structure and Content
22.3.2 IAS 2—Inventories
22.3.3 IAS 5—Non-Current Assets Held for Sale and Discontinued Operations
22.3.4 IAS 7—Statements of Cash Flows
22.3.4.1 Statements of Cash Flows: Presentation
22.3.4.2 Reporting Cash Flow from Operating Activities
22.3.4.3 Foreign Currency Cash Flows
22.3.5 IAS16—Leases
22.3.5.1 Sale and Leaseback Transactions
22.3.5.2 A Sale and Leaseback Results in Finance Lease
22.3.5.3 A Sale and Leaseback Results in Operating Lease
22.3.6 IAS 24—Related Disclosures
22.3.6.1 Disclosures
22.3.6.2 Exemption to Disclosures Rules: Government-Related Entities
22.3.7 IAS 27—Consolidated Financial Statements
22.3.7.1 Presentation of Consolidated Financial Statements
22.3.7.2 Scope of Consolidated Financial Statements
22.3.7.3 Consolidation Procedures
22.3.7.4 Loss of Control
22.3.7.5 Accounting for Investments in Subsidiaries, Jointly Controlled Entities and Associates in Separate Financial Statements
22.3.7.6 Disclosure
22.3.8 IAS 32—Financial Instrument—Presentation
22.3.9 IAS 33—Earnings Per Shares
22.3.10 IAS 34—Interim Financial Reporting
References
Part VI Case Study
23 Apple and Microsoft
23.1 Industry Analysis
23.2 Apple
23.2.1 Overview
23.2.2 Competition
23.2.3 Business Strategy
23.2.4 Financial Statements
23.2.4.1 The Consolidated Balance Sheet
23.2.4.2 The Consolidated Statement of Income
23.2.4.3 Consolidated Statement of Comprehensive Income
23.2.4.4 Consolidated Statement of Shareholders Equity
23.2.4.5 Consolidated Statement of Cash Flows
23.3 Microsoft
23.3.1 Overview
23.3.2 Competition
23.3.3 Business Strategy
23.3.4 Financial Statements
23.3.4.1 Consolidated Balance Sheet
23.3.4.2 Consolidated Statement of Income
23.3.4.3 Comprehensive Statement of Income
23.3.4.4 Consolidated Statement of Shareholders Equity
23.3.4.5 Consolidated Statement of Cash Flows
23.4 Financial Analysis
23.4.1 Industry Analysis—Porter Five Forces
23.4.2 Common-Size Balance Sheet Analysis
23.4.3 Common-Size Income Statement Analysis
23.4.4 Comparative Financial Statements Analysis
23.4.5 Financial Ratio Analysis
23.4.6 Comparative Financial Ratio Analysis
References
Part VII Non-GAAP Reporting & Earnings Management
24 Non-GAAP Reporting
24.1 General
24.2 Non-GAAP Metrics’ Concerns
24.3 Perceived Advantages and Fears
24.3.1 Advantages of Non-GAAP Metrics
24.3.2 Perceived Disadvantages
24.4 Illustration of Non-GAAP Reporting
24.5 Identification of Risk-Accounts’ Tools
24.6 The Disaggregation of the Statement of Income
24.7 Improving the Intermediary Measurements of Profits
24.8 Concluding Remarks
References
25 Earnings Management Through Excessive Reserves and Provisions
25.1 General
25.2 Creation of Reserves
25.3 Accounting for Provision
25.3.1 Creation of a Provision
25.3.2 Use of a Provision
25.3.3 Reversal of a Provision
25.4 Earnings Management Cases in the United States
25.4.1 Cookie Jar Reserves
25.4.2 Use of Hidden Reserves
25.4.3 Undisclosed Changes in Accounting Methods
25.5 Detecting Earnings Manipulations
References
Part VIII Valuation
26 Valuation Accounting
26.1 General
26.2 Importance of Asset Valuation
26.3 Valuation Principles
26.3.1 Historical Cost Method of Valuation
26.3.2 Current Cost Method of Valuation
26.3.3 Realizable Value
26.3.4 Present Value
26.4 Valuation Methods
26.4.1 Method 1: Comparable Analysis (“Comps”)
26.4.2 Method 2: Precedent Transactions
26.4.3 Method 3: DCF Analysis
26.4.4 Book Value
26.4.5 Liquidation Value
Glossary of the Terms
Index